快扣 (FAST) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fastenal Company Q4 and Fiscal Year 2017 Earnings Results Conference Call.

(Operator Instructions)

It is now my pleasure to hand the conference over to Ms. Ellen Stolts of Investor Relations.

Ma'am, you may begin.

Welcome to the Fastenal Company 2017 Annual and Fourth Quarter Earnings Conference Call.

This call will be hosted by Dan Florness, our President and Chief Executive Officer; and Holden Lewis, our Chief Financial Officer.

The call will last for up to 45 minutes and will start with a general overview of our quarterly results and operations, with the remainder of the time being open for questions and answers.

Today's conference call is a proprietary Fastenal presentation and is being recorded by Fastenal.

No recording, reproduction, transmission or distribution of today's call is permitted without Fastenal's consent.

This call is being audio simulcast on the Internet via the Fastenal Investor Relations homepage, investor.fastenal.com.

A replay of the webcast will be available on the website until March 1, 2018 at midnight Central Time.

As a reminder, today's conference call may include statements regarding the company's future plans and prospects.

These statements are based on our current expectations and we undertake no duty to update them.

It is important to note that the company's actual results may differ materially from those anticipated.

Factors that could cause actual results to differ from anticipated results are contained in the company's latest earnings release and periodic filings with the Securities and Exchange Commission and we encourage you to review those factors carefully.

I would now like to turn the call over to Mr. Dan Florness.

Thank you, Ellen, and good morning, everybody, and thank you for joining us on our fourth quarter earnings call.

First off, happy new year and welcome to 2018.

Before I touch on the quarter, I'd just like to share a couple of stories.

One is the conversation I had with Bob Kierlin, our Founder of Fastenal, about a week ago.

Being -- just finishing my second year in this role, it's nice having Bob around to share thoughts with periodically and I shared with him the -- my President's letter for the annual report we'll be filing here in early February.

And he stopped back in after reading through it and he said, "I like your letter, Dan.

I do have a question for you, though.

On the right-hand column of the first page, I really think you should change it." And I'm like, "Okay." And he said, "It feels like you're on an apology tour because you're frustrated with Q4." And he said, "You know, what are you doing right now?" Your -- Fastenal is working to evolve the business.

We're -- we've been ramping up our business activity.

We've been ramping up our development activities as it relates to our district managers and our branch managers.

We've been ramping up the business to support vending at a higher level and you're ramping up to turn on Onsites, and all of these things require people and energy and a lot of it and we're doing it quickly." And he said, "You know, you've -- we've tripled the number of Onsites we have in a couple of years and we have a whole bunch to turn on.

And again, that takes energy to do.

Explain that.

Don't apologize for it.

Explain that." And that was helpful.

I did modify my President's letter as a result and, hopefully, explaining it better.

One thing you'll notice when you read the President's letter, I touch a lot on the -- what we're trying to accomplish as well as I explained a lot about the year from the standpoint of pretax because if you get into after-tax, it starts to get a little noisy and we'll touch on that later in the comments.

The other aspect of the story is the conversation I had with our RVPs this morning, our regional vice presidents.

In that call at 7:00 Central this morning, I thanked them for 2017, wished them all very good luck in 2018; shared with them my thoughts on the health and capabilities of our business and how much that's improved in the current year; and the excitement there is when we have financial success, career success, our customers have a good year; but I challenged them on a few points, and the first one centered on gross margin.

And in the last call, I really felt our gross margin in the fourth quarter would come in at 49% and we're about 20 basis points below where I thought we'd be.

And if you think of our gross margin, there's really -- we talk about customer mix and end market mix.

I oftentimes think about it in the simple context of there's really 3 components, ignoring customer mix for a second, as fasteners, non-fasteners and freight.

When you move in a relatively inexpensive product per pound around a large continent, freight's a big deal as well.

In the case of non-fasteners, our largest group of products, it's about 2/3 of our business.

A lot of noise in the summer and fall about what was going on in that marketplace.

A lot of e-commerce change really impacting that marketplace.

A lot of noise in the market, some competitors lower -- adjusting their prices and what that might mean for Fastenal.

Right now, non-fasteners -- and our non-fasteners, about 25% of that goes through a vending platform so we go to market in a very different channel than our competitors.

Our non-fastener business is growing as strong as it's ever grown.

Holden will touch on that later in the call.

Our gross margin in non-fasteners was 10 basis points higher in the fourth quarter than it was in the third and it's dead-on even with where it was a year ago.

And I feel really good about that.

All the noise that's going on, all the stuff that's going on in the marketplace, our team is reacting very well and I shared that with our team this morning.

In the case of fasteners, we've seen our gross margins slip from both a year ago and from third quarter.

And there's really 2 things that are driving it: One, a disproportionate amount of the growth is coming from large customers, a lot of OEM fasteners, and that's always going to hurt margin and I get that; but part of the slippage is occurring because the fasteners are seeing inflation right now and we're a little rusty on addressing that.

Perhaps I'm not pushing the group fast enough, perhaps the group isn't moving fast enough or maybe it's a little bit of both.

We're a little rusty on that.

We lost some gross margin in the quarter, but that's not what was frustrating me because I believe that's fixable and I believe the things we have in motion will fix that.

What frustrated me was on the freight side.

In an uncustomary fashion, we were sloppy on freight in the fourth quarter.

And it's not a revenue problem, it's an expense problem and we were careless and sloppy and it -- it involved our distribution centers, it involved our branch network and it involved everybody that supports those 2. So it involved 20,000 people and we were careless in the fourth quarter and that's where our 20 basis points is -- was lost.

We always deleverage a little bit in the fourth quarter because our sales are dropping off, but we did more than normal and that was frustrating me.

Bob also pointed out, "Yes.

And some of that is because you're adding capacity to handle the volumes you see in the new year and to support those Onsites that are turning on.

Never lose sight of that.

And -- but if you're being sloppy, just fix it.

Don't (inaudible) , just fix it." So that was my conversation with our RVPs that's related to gross margin.

Our second conversation talked about -- we spoke about rent and I'm talking about dollars spent on rent throughout our network.

A year ago, I really challenged the group and said, "We need to look at the dollars we spend on our buildings." And from Q1 2017 to Q4 2017, it can't grow.

And in our 50-year history, that's never happened.

But this year, it can't because we -- as we're migrating to the Onsite platform, as we're continuing to leverage and lean up our income statement to be more nimble in the marketplace, that can't grow.

I'm pleased to say between the first quarter of 2017 and the fourth quarter of 2017, the rent dollars we spent dropped $360,000.

Now, on the context of a $4.5 billion company, that might not mean a lot.

It was huge in our business because we'd never done it before.

And I challenged them to do it again in the next 12 months between Q4 '17 and Q4 '18.

Let's repeat that feat.

Some of it's occurring because we're consolidating some of the business where -- as we're moving some of our business into Onsites, as our growth is driving into Onsites, we're rationalizing everything we do and we're consolidating some branches.

But everything we're doing, we're doing to grow faster.

It isn't about saving expense dollars, but I did want to see if we could harvest some of that because I'd rather deploy those dollars elsewhere, which brings us to the quarter.

The -- our pretax earnings for the fourth quarter of 2017 and for 2017 grew double digits.

I can't think of a better way to celebrate 50 years in business.

Our earnings per share for the year came in at just over $2, $2.01.

That's a bit noisy of a number given that we had some tax legislation passed late in the year and that impacted our income statement.

As you all know, most of our revenue and most of our profits are generated in the United States of America.

I think it's just over 85%, I think it's 88% to be exact.

And we have historically paid a tremendous penalty for being a U.S.-based business in our global marketplace.

And our tax rate has been dropping over the years as our international's gotten to be bigger.

So it creates some noise.

But if you look at ignoring that tax change, our earnings in the -- our pretax earnings -- well, our earnings, excuse me, would have grown about 12% -- just over 12% in the quarter and just over 11% in the year.

Again, an excellent way to finish the year.

Daily sales growth is strong in the fourth quarter.

We grew almost 15%.

That was lifted a little bit by our Mansco acquisition earlier in the year.

Without it, we would just have been over 13%.

And for the year, our daily sales grew 11%.

As mentioned, we are aggressively investing to support our Onsite initiative, our vending initiative, our e-commerce initiatives, but we obtained growth -- good operating leverage in the fourth quarter and for the year.

I believe we can sustain this momentum as we go into 2018.

There was a little window dressing going on by some of our customers late in the year and our cash payments just abruptly halted between Christmas and New Year and cash came in like crazy the first week of January, so a little window dressing that hurt our cash flow late in the year.

I'm pleased with the fact that after making a sizable investment in what we called CSP 16, our inventory in 2016, we were able to lower our days on hand of inventory nominally in the 2017 and we'll work to do that again in 2018.

And that was the third item I covered with the RVP group this morning.

Our share price has had a nice run in recent months.

Really, in 2017 in general, it looks happy along the way, but it had a nice run.

And because of that and our desire to maintain a meaningful dividend for our shareholders, we raised our dividend as we announced last night.

Our -- I'm going to Page 2 of the flip book if you're following along, but our Onsite initiative used to be a regional thing.

It was something we were doing aggressively.

We were doing aggressively in some of our older regions, especially in the upper Midwest.

We were doing it aggressively in Mexico and seeing incredible growth in recent years because of it.

What I'm really proud of is we've turned Onsite, a regional thing, into a company thing.

Two years ago when we really started to move the Onsite signings up, we moved the needle because instead of signing a handful, 8, 10, 12 Onsites in the year, we signed just over 75 because 25% of our district managers went out and signed an Onsite.

Our businesses -- our success stems a lot from that group, about 240-some people scattered around the planet, mostly North America.

In 2016, we dramatically increased our Onsite signings, added about 100 to it because 52% of our district managers signed an Onsite that year.

Coming into this year, we had big goals to expand that another 100.

We came in at 270 Onsites because 73% of our district managers signed an Onsite this year.

It's not a regional thing anymore, it's a company thing.

And it's moving the needle on our business, it's moving the needle on our growth.

We have a big goal for next year.

Let's add another 100.

Don't know if we'll hit that goal, but our stated goal right now is 360 to 385.

If you were in some of our internal meetings, you might even hear us say, "Heck, let's go for 400." But our stated goal is 360 to 385.

With the expansion of our Onsite, we have almost 3,000 in-market locations across the planet today, again, most in North America, versus just over 2,900 a year ago.

We signed 19,355 vending devices in 2017, up nicely from last year.

The one positive as we've rapidly expanded our footprints, we've grown in basically a decade from literally no vending machines to just over 70,000.

When you do something very quickly, you make some mistakes along the way, you're aggressive along the way.

And we remove a number of devices.

We install 10, we really need 8. We installed 5, we really need 4, that kind of stuff.

Sometimes we installed one, maybe we shouldn't have installed that one.

And so one thing that's very uplifting when I look at 2017 is the percentage of devices, what we're removing every year is starting to improve.

And we saw that in the final 3 quarters of 2017.

So said another way, you can fill the sink a lot faster if you turn on the faucet and you plug the drain, and we plugged up the drain a bit.

Our goal is to sign 21,000 to 23,000 devices this year.

National Accounts.

The group is executing at an unbelievable level.

They're busy, they're creating a lot of work at our branch network and they're creating the need for us to invest heavily.

Our National Accounts grew 14.5% for the year, 18.5% in the fourth quarter.

My compliments to the group and to everybody else in the company who supports that business.

Finally, that's not a bullet on the chart.

Our construction has gained momentum as we've gone through 2017 and that's a really pleasing thing because in the last decade, we became an ever better company in the industrial market.

We doubled in size, but our construction business in that same decade grew about 35%.

That's a cumulative number, not an annual number, a cumulative number.

We really struggled to gain footing and growth.

We started to get a taste of that as the year went on.

Our goal was to grow 5%.

I think, for the year, we grew around 6%, but we exited the year growing double-digits.

So I feel really good about what that means for 2018.

With that, I've overstayed my welcome.

I'll let Holden talk.

Great.

Thank you, Dan.

Good morning.

I'm going to begin with a quick recap of our 2017 results before moving on to the discussion of the quarterly performance.

In 2017, Fastenal generated $4.4 billion in sales, which is up 10.8% from 2016.

We had one fewer selling day in the year so, on a day's basis, we were up 11.3%.

We did get the economic tailwind that began in late first quarter and strengthened throughout the year.

However, we also believe our growth drivers have allowed us to outgrow the marketplace and I want to provide a little bit more color on those.

For vending, excluding units in our leased locker program, we finished 2017 with over 71,000 installed machines, up 8,600 units or 14% over 2016.

Signings were below our full year goal but up 7%, but at the highest level since 2013.

We also saw higher revenue per machine of 2% to 3% and removals were down 4% and because of that, revenue through our machines rose more than 15% in 2017.

In 2018, we're targeting signings of 21,000 to 23,000.

We signed 270 new Onsite agreements in 2017, shy of our goal of 275 to 300, but well above last year's 176 signings.

Growth of sales through Onsites, excluding branch transfers, accelerated through 2018 and was up 22% for the full year.

We're targeting 360 to 385 signings in 2018.

Lastly, National Accounts paced the overall business with daily sales growth of 14.5% in 2017.

Sales to our largest customers accelerated through the year with December up 19.7%.

Through a greater extent than last year, this was achieved both through a combination of new accounts and by penetrating existing accounts.

Margins in 2017 stabilized.

Our gross margin finished at 49.3%, which was down 30 basis points.

This was largely due to product margin, which was mostly impacted by a combination of product and customer mix and the inclusion of Mansco since acquiring it on March 31.

Operating margin finished 2017 at 20.1%, flat with last year.

Operating expense leverage offset the gross margin decline, which was most significantly attributable to occupancy as we shut 120 net public branches in 2017.

This was partly offset by the absence of vendor freight credits received in 2016 related to CSP 16, increased amortization and higher legal settlement activity.

At the gross margin line, mix will likely remain a headwind in 2018.

We've recently taken actions to offset product inflation and the degree to which this variable affects gross margin in 2018 will depend on the effectiveness of these actions.

At the operating expense line, we think there's room to leverage occupancy further and we would expect some leverage over employee-related expenses as growth in incentive compensation moderates.

Our interest expense was up 40% in 2017 owing to higher rates of the debt assumed in the Mansco acquisition.

Our tax rate fell from 36.8% in 2016 to 33.7% in 2017 due largely to the discrete items related to the recently passed tax reform, which I'll discuss in the quarterly recap.

Excluding this, our tax rate would have been 36.5% in 2017.

It all blended to a full year 2017 EPS figure of $2.01, up 16.2% from 2016.

If I exclude the discrete tax items, our EPS would have been $1.92, up 11.3% from 2016.

Now, shifting to the fourth quarter and looking at Slide 5 of the deck.

As Dan stated, total and daily sales were up 14.8% in the fourth quarter, which represents acceleration from 13.6% daily sales growth in the third quarter.

Mansco contributed 140 basis points to this growth.

The fourth quarter finished well with December's daily sales growth coming in at up 14.7% or up 13.3%, excluding Mansco.

In terms of market tone, conditions remain healthy.

Macro data remained favorable with the PMI averaging 58.9 in the fourth quarter.

Industrial production growth accelerated.

It's now rising at a low to mid-single-digit rate.

Manufacturing end markets continued to lead with strength in heavy and general manufacturing, transportation and energy.

The positive inflection in the quarter was in construction, as Dan mentioned, which was up 9.6% in the fourth quarter and was up 11.9% in December.

Feedback from the field on construction began to improve late in the first quarter.

The uptick in November and December seems to reflect activity levels catching up with that sentiment.

From a product standpoint, we experienced acceleration in both fastener and non-fastener lines.

From a customer standpoint, National Accounts accelerated again, growing 18.4% in the quarter with 72% of our top 100 accounts growing.

Growth to smaller customers was steady and nearly 65% of our branches grew in the fourth quarter, up from 64% in the third quarter and 62% in the second.

We have no reason to believe that the demand we experienced in the fourth quarter hasn't continued into the first quarter.

That said, be aware that the storms in the eastern and southern regions of the U.S. have had a significant impact on business activity in the first half of January.

Now on to Slide 6. Year-over-year, our gross margin was 48.8% in the fourth quarter, down 100 basis points from the fourth quarter of '16.

We had a particularly difficult comparison with the fourth quarter of '16 gross margin having been unseasonally strong on the back of vendor credits received as a result of CSP 16.

We experienced a downtick in our product margin as a result of mix, inclusion of Mansco and, to a lesser degree, product inflation in fasteners.

Freight was a significant drag in the period owing to higher payments to third party shippers and incremental investment in drivers and equipment.

On a sequential basis, our gross margin was down 30 basis points.

While it is not unusual for our gross margin to decline sequentially, we did expect slightly better.

And I think 2 things are notable: First, the freight variables cited in the annual comparison fell heavily into the fourth quarter relative to the third; second, the fourth quarter did see price/cost pressure in our fastener line.

This was modest in the period.

However, given continued inflationary conditions in the marketplace, we did initiate actions in the fourth quarter, including pricing, to defend our profitability.

We would expect these actions to provide stability to our margins in 2018.

Our operating margin was 18.7% in the fourth quarter, down 60 basis points year-over-year.

The 100 basis point decline in gross margin was partially offset by 40 basis points of operating expense leverage.

Looking at the components of that, occupancy-related expenses were down 1%, the largest element being the continued reduction of our public branches in the quarter and through the year.

Selling transportation-related expenses were up 7.4%.

The most significant element of that was a 17% rise in fuel primarily from higher prices for unleaded.

This leverage was partly offset by the cumulative effect of small items such as lower vendor credits given the absence of a major CSP initiative in '17, higher legal costs and higher amortization.

Employee-related costs were up 15.5%, 120 basis points of which relate to Mansco's headcount and incremental expenses related to implementation of last year's DOL rules, the latter of which will fully anniversary in the first quarter of '18.

The remaining increase is a function of the reset of incentive comps throughout the organization given our return to strong growth in 2017 and an increase in overall staffing.

Total headcount growth was up 4.8% or up 7.7% on an FTE basis.

It all blended to a fourth quarter EPS figure of $0.53, up 33.5% from fourth quarter of '16.

The quarter included 2 discrete tax items: A gain related to deferred taxes on fixed assets and a charge related to a transition tax on foreign cash and earnings.

This added up to a onetime tax benefit of $24.4 million.

Excluding the discrete items, our tax rate would have been 36.2% and our EPS would have been $0.45, up 12.2%.

We are still refining our understanding of various elements of tax reform, but expect our full year rate to settle at a range of 24% to 26%, excluding any additional discrete items that may arise during the year.

Turning to Slide 7. We generated $129 million in operating cash in the fourth quarter, which was 85% of net income.

We believe this is a function of the timing of receivables, which I'll cover in a moment.

For the full year of 2017, we generated a record $585 million, which represented 101% of net income.

These improvements are primarily a function of better earnings.

Net capital spending in 2017 was $113 million, down 39%, largely from the absence of spending on vending machines related to leased lockers.

This is below our target for 2017 of $127 million, which cannot be attributed to a single item but to slightly lower capital spending in a number of places in the company.

For 2018, we are anticipating capital spending of $149 million with the increase being largely attributable to spending, upgrading or expending hub capacity and property purchases for potential future expansion.

We finished the year with debt comprising 16.5% of total capital, consistent with last year and a level that provides ample liquidity to invest in our business and pay our dividend.

Given our expectations for earnings and cash flow in 2018 and our desire to maintain an attractive dividend yield, we have increased our quarterly dividend from $0.32 to $0.37 in the first quarter.

In terms of working capital, we were pleased with inventories.

Excluding Mansco, our inventories were up 8%, trailing sales growth due to the ability to leverage the heavy investment in branch inventory in 2016 and more energy enterprise-wide on this line.

Overall, days on hand fell by 7.

Receivables growth, excluding Mansco, was up 20% in the fourth quarter '17.

Accelerating growth generally and relative growth from National Accounts played a role as it has all year.

In the fourth quarter, however, this was compounded by the end-of-week timing of holidays in December, which caused a significant volume of receivables to fall into 2018.

Payables, excluding Mansco, were up 34%.

Last year's fourth quarter was unusually low with the wake of high CSP 16-related purchases.

That's all for our formal presentation.

So with that, operator, we'll turn it over for questions.

(Operator Instructions) And our first question will come from the line of David Manthey with Baird.

Just a quick 2-part question here, one mechanical and one soft side.

First, could you level set everyone on your FIFO accounting and how the price increases flow through the P&L?

I'm just interested in this price increase that you recently put through.

If you could talk about maybe magnitude and timing of the effect on both the top line and the gross margin as it flows through?

That's one.

And then, second, what is the main message that you as a leadership team are sending out to the field this year?

And I know you mentioned a few things.

I'm wondering about aggression on new business and focus on value and Onsite and price increases.

But, Dan, when you had that conversation with your RVPs, what is the #1 most important message that you would have those guys and gals take out to their teams and their customers today?

I'm going to start with the second part, then I'll go to the first.

And, Sheryl or Holden, feel free to chime in if you feel my answer is somewhat lacking.

As far as the main message, last year talked about growing -- a simple message, grow sales and grow earnings.

We had struggled for a few years, obviously amplified by the oil and gas slowdown and how it hit our business.

The message this year just had one more thing to it: Grow sales and grow earnings.

Let's grow it double-digit.

And then, the concept of think big.

And think big is about -- one thing we did in 2017 is we worked with all of our district leaders.

They all -- all of our district managers came in for a 2-day workshop -- 1.5-day workshop and it was about developing a business plan, a 5-year business plan for their business.

And think big, that's basically this: Have a plan.

Incorporate our growth drivers: Onsite, vending, construction, CSP 16, National Accounts, international.

Incorporate that into your plan and vet your plan.

Share it with your peers.

Share it with a regional, whether it's your region or not that you respect, share it with somebody else.

And then, share it with every member of your team because if you get great people pursuing a common goal, you can accomplish great things and you can get the most out of great people and be more successful and move faster.

So our biggest message is have a plan and grow your business and think big about it.

In regards to -- we're on FIFO accounting and so part of our inventory increase for the year is inflation.

I'm not going to get too deep into the magnitude because I just don't want to get ahead of ourselves, Dave, but it's really 1/3 of our business is fasteners and we're getting some squeezing there.

And in some cases, we have mechanisms in place that's tethered to indices.

As far as on a 6-month basis, there's ability to raise prices in an inflationary period and lower prices in a deflationary period, but we just need to be really crystal with that.

And I think part of the issue, so I'm getting a little bit beyond your question, part of the issue has been we've been -- we're so wired to grow, grow, grow -- and even Holden and I are having this conversation this morning.

We're so wired to grow, grow, grow that sometimes, when you're having a conversation with a customer about turning on 5 or 7 additional facilities, you want to balance that with the pricing aspect.

But our customers do value the service in what we bring, whether that's in our traditional branch model or our Onsite model and/or our vending model, and it's really impressing upon the way for us to provide that service is we need to price the product fairly.

And we're doing a great job with that on our vending business and our non-fastener business in general.

We're just not moving fast enough on our fastener business.

So I'm going to shy away from quantifying the impact.

But, Holden, if you want to chime in?

Yes.

And I might just chip in to Dave as well.

If you recall, we actually had a modest increase in price that we put in, in the second quarter in response to what we -- we were seeing inflation in the channel.

That really was intended to go after a sliver of the business.

And at the end of the day, the amount that which price moved our revenue line this year was fairly immaterial.

We felt that it achieved a goal, but it was fairly immaterial overall.

This iteration, now that demand has gotten stronger and cost inflation has gotten stronger, is intended to address a larger slice then we had done in the past.

And it's really intended to address the same thing.

It's to address the inflation that we see in what is a relatively long supply chain in the fastener business.

So we would expect that the -- without getting into details about quantity, we expect it would be more significant this time around than it was certainly with the smaller one in the second quarter.

And, Holden, we could see some of that impact as early as first quarter, correct?

Yes.

We would expect that we would be able to speak about it in concrete terms by that point.

And our next question will come from the line of Ryan Cieslak with Northcoast Research.

First question, just really quick, a follow-up on the gross margin and replacing side of things.

Holden or Dan, the way to think about the pricing implementation, is it give you the opportunity to once again get ahead of the COGS inflation on the fastener side?

Or should we be thinking about this more as a catch-up to what maybe you saw here in the fourth quarter with regard to that headwind?

Yes.

I would characterize it as a bit of a catch-up in this regard.

I mean, as Dan had indicated and I talked about in the script, was we did see the fastener gross margin in the fourth quarter tick down as a result of product inflation.

So the group has done a great job staying ahead of it on the non-fastener side.

We've gotten a little bit behind on the fasteners side.

And so this is intended, as much as anything else, to begin to cover up some of that lag.

Okay.

Okay.

Fair enough.

And then, Dan, when we think about the opportunity here in 2018, obviously '17 was a really good year for you guys in terms of top line.

Not looking for specific guidance, but what maybe are some of the puts and takes on the top line in the context that comps do get more difficult?

And what are maybe some of the incremental drivers?

And how do we sort of maybe frame up what the opportunity could be?

Can you actually grow again double digits?

Or should we be maybe tempering our expectation, just given the comps get more difficult?

As far as the opportunity drivers for 2018, here are the things that come to mind for me, we have great momentum in our business.

As I mentioned earlier, our National Accounts team is executing about as well as I think we've ever executed in our history.

We have built-in lift from the -- if you think about the vending machines that we've signed, that we've been deploying late in the year or throughout the year, but they've been strong throughout the year.

The fact that we're removing fewer and so I feel better about our installed base and how we'll be able to grow that in the next 12 months.

Our Onsites, we have a record number of Onsites that we signed.

I feel we have great momentum coming into the year because, again, Onsite is now a company thing.

It's not touching a small chunk of our business.

It's touching the business.

So I feel very good about our growth drivers in the couple of years momentum we have built into them and we're finishing the year strong.

And I feel really good about the tax bill signed late in the year and its ability to list -- to lift the industrial marketplace in the United States.

The industrial marketplace -- and I don't want to get too deep into the discussion here, but let's be honest.

The industrial marketplace in the United States has been the highest-taxed population on the planet.

And we're unleashing some of that potential with the tax change.

I mean, I look at our business.

For example, I believe the S&P 500 had an effective tax rate of about 27% before the Tax Act.

Our effective tax rate in recent years has been about 10 points higher than that, 36.5%, 37%.

And we're indicative of that example.

And I believe for a lot of our customers, it unleashes their potential to think bigger about their business and to grow faster.

And we're going to participate in that growth because we're going to help support their business.

And I feel really good about that coming into 2018 and I think it has some legs to it.

And, Ryan, I just want to chip in one thing from the earlier question just to make sure everyone understands.

Although product inflation was a factor in fourth quarter, it was well behind product mix, the impact of Mansco and the issues around freight in the quarter in terms of an impact.

So when we say that we're sort of catching up, if you will, I don't want to leave the impression that we've fallen particularly far behind.

It was a fairly minor factor in the fourth quarter.

We're acting because we needed to make sure that it doesn't expand as an issue in 2018.

Fourth quarter was above.

Fourth quarter was above.

Okay.

Got you.

Just really quick on freight, Dan, just really quick, if I can.

Is the freight component more of an internal or company-specific element or are you actually seeing some pressure from the market as well as it relates to maybe drivers?

You mentioned fuel.

How much of it is more company-specific and execution versus maybe some market headwinds that you guys are seeing right now?

It's us.

It's company-specific.

It -- a piece of it is seasonal, but that was true last year too.

But when I look at the impact of fourth quarter versus third quarter a year ago and the impact of fourth quarter versus third quarter in 2017, it's us because what we're -- the relativeness of what we're charging for freight, the relativeness of how much we're doing internal versus external.

We move most of the freight on our own trucks, which is a huge competitive advantage.

We still manage it well.

And I'm going to cut you off with that question and we'll go on to the next one because we're running a little a tight on time.

Our next question will come from the line of Chris Dankert with Longbow Research.

I guess, just trying to think a bigger picture here.

How do we think about the pathway to profit kind of in the context of Onsite being such a key driver now and kind of how that looks versus traditional stores?

Yes.

Okay.

I'll take that one.

The pathway to profit historically was about growing our average branch size.

And as that would happen, the operating expenses dropped dramatically.

A branch doing $50,000 to $80,000 a month has operating expenses well into the $30,000s.

A branch doing $150,000 or $250,000 a month has operating expenses that are well down into the mid, if not low $20,000s, but in mid-$20,000s anyway.

And so that's really what the pathway to profit was about was letting the inherent profitability shine through.

Onsite creates a challenge for pathway to profit in that your revenue growth is coming from our growth drivers.

Vending helps our branch revenue grow.

CSP helps our branch revenue grow.

Onsite actually helped -- causes the branch revenue to either tread or maybe go back slightly.

So if I have a $20,000 a month account in a $150,000 branch and I move that to an Onsite to turn it into a $100,000 customer, the branch goes from $150,000 to $130,000.

And so we have negative leverage going on there, which is -- which hurts the pathway to profit concept.

Our job is -- can all those other things get us back to $150,000.

The morphing that we've been talking about in our business where we've been closing some branches, so if we move out enough customers in a handful of branches, maybe we go from 10 branches in that market to 9, which lets us claw back a little bit to the pathway to profit because you -- the other 9 have a higher average.

And so it's really about in -- on the branch side.

The pathway to profit is as healthy as ever.

The Onsite creates a little challenge for it, but I'll take that challenge because it allows us to grow in Onsites in attractive business from the standpoint of our ability to grow with it and our ability to generate a return.

And one thing I'll contribute to that is if you do look at the Onsites that predate this becoming a growth driver, the operating margins are above where the newer Onsites are and so there is a pathway to profit element that's there that's getting lost only because we're opening so many.

The intermediate-term measure of success is the degree to which we use the pathway to profit to expand a maturing Onsite base and to begin to refill what we took out of the branch and then they sort of go down that pathway to profit a second time, if you will.

And, I guess, if I could just pull it a tiny bit more, I guess, is there a way to break out the Onsites by age then?

Maybe we can back into where you started the year, where you finished the year?

But as far as you're trying to think about profitability and size, the net impact for 2018 and beyond, I mean, is there any way that we can kind of look at profitability by Onsite and then some divisions at all?

So we do.

We've not necessarily gone down the path of sharing that year-by-year with the investment community, but we do track that internally.

I mean, what I would tell you is that from the point that you start an Onsite, probably between, call it, 6 quarters later, you're sort of where the Onsite should be and sort of a steady state.

And then, from there, you begin doing the things you need to do to improve the margin and go down that pathway to profit, looking for product substitution opportunities, looking for additional volume opportunities.

So that path down the pathway, it probably begins in earnest between 4 and 8 quarters after sort of the signing and that progress begins and then, ultimately, you get there.

But with these new ones since it being a growth driver, I'm not sure I necessarily figured out the exact date that you get to a corporate margin on the Onsite business from the time you start.

Our last question will come from the line of Robert Barry with Susquehanna.

I did actually want to follow-up on a comment Holden made during the prepared remarks about stability, expecting stability in gross margin in '18.

Was that just a price/cost comment?

And then, maybe we should layer on what has become this kind of normal 20 to 30 bp hit from mix from the growth drivers?

So like a typical decline...

Yes.

No.

Thank you for clarifying.

No, that's right.

It was intended to be a comment about what we're doing with pricing.

And it was really twofold.

One to just to let you know that we are taking sort of product inflation seriously and taking steps to do it, but the second is we're not necessarily looking at this as an opportunity to boost our margin, if you will, right?

We're trying to defend our margin from product inflation that everybody in the marketplace knows that's there.

And so I think that you're right to think about it in terms of it's intended to offset product inflation and then the other variables that are always there on gross margin are still there.

Right.

So thinking about just kind of level setting a base case for '18, it seems like price is offsetting cost inflation and then you've got the 20 to 30 basis point impact from the growth drivers and so maybe that's kind of what we see.

Would that be kind of a good expectation?

Yes.

I think it's a good place to start and then we'll try to do everything we can on freight and other elements, but I think a good place to start is what we said before, which is every year we kind of start off in the hole 20 to 30 basis points on gross margin because of product and customer mix.

And when you see how fast our National Accounts are growing, and international's growing, the Onsites are growing, there's no reason to think that, that's any different in 2018 than it was in 2017.

Got it.

And if that happens, do you think you could get the operating leverage...

Yes, Bob.

Sorry.

I'm going to...

You want us out there?

I thought I had 1 minute left.

We try to religiously keep this to 45 minutes because we realize it's earnings season and everybody's busy and has other calls to hop on.

Fair enough.

Thank you, everybody, for attending our call today.

And as that last question touched on, it forces us to focus very, very intently on the operating expenses within our business, invest wisely to support growth, invest wisely to grow faster and -- but manage our expenses prudently.

Thanks, everybody.

Have a good day.

Ladies and gentlemen, thank you for your participation on today's conference.

This does conclude our program and we may all disconnect.

Everybody, have a wonderful day.